What is SOFR?
- In 2014 the Federal Reserve convened the Alternative Reference Rates Committee (ARRC) to plan the transition away from U.S. dollar LIBOR. The ARRC’s criteria for U.S. dollar LIBOR’s replacement included methodological quality, accountability, governance, and ease of implementation. In the end, the ARRC recommended the Secured Overnight Financing Rate (SOFR).
- The New York Fed has published SOFR every day since early April 2018. SOFR is the broadest available measure of rates in the overnight repurchase agreement (repo) market in which Treasury securities are posted as collateral.
- Note: In 2018 Andrew Bailey, the head of the UK Financial Conduct Authority, explained that firms should treat the discontinuation of LIBOR as an event that will happen and that they should be preparing for it.
SOFR and the Transition from LIBOR
By: Michael Held – Federal Reserve Bank of New York
How is SOFR expected to behave?
A compound average of the SOFR rate has tended to be very close to a compound average of the effective federal funds rate (EFFR), the rate that the Federal Reserve bases its policy target on. Thus, despite the fact that it is a secured rate and has some day-to-day fluctuations, SOFR should be expected to move very closely with Federal Reserve policy and very closely with overnight unsecured rates like EFFR over time.
Historical Proxies for the Secured Overnight Financing Rate
By: David Bowman – Federal Reserve Board
Is SOFR better than LIBOR?
Loans indexed to LIBOR can offer insurance to lenders against adverse funding shocks. Indexing loans to a rate that does not reference bank funding costs directly, such as SOFR, does not have this property. I have developed a stylized model to study this mechanism and to get a sense of quantitative magnitudes. For the aggregate economy under regular conditions, this mechanism should not have first-order effects if LIBOR is replaced by SOFR. However, for extreme conditions such as those experienced in 2008, the loss of this automatic stabilizer may not be trivial. In an economy that uses SOFR for indexing loan rates, banks may need to change risk management practices with respect to their loan exposures.
Is SOFR better than LIBOR?
Author: Urban J. Jermann
From:Wharton School of the University of Pennsylvania
